Timing of European CDS probe piques interest

KatyBurne

(Adds banks being investigated in last paragraph.)

NEW YORK -(MarketWatch)- The timing of European authorities' antitrust investigation into the $30 trillion credit default swap market has industry participants wondering what sparked the probe now, and not before.

The decision to review alleged preferential treatment of certain vendors by major swap dealers is curious because regulators are already working to break up the clubby world of derivatives trading by steering over-the-counter instruments onto transparent platforms with near-real-time reporting, said Kevin McPartland, senior analyst at TABB Group, in a market commentary Tuesday.

"With huge OTC derivatives reform happening around the world that presumably will open up the market to more competition, why bring an antitrust suit now?" McPartland asked. "If an oligopoly really does exist, won't derivatives reform end it anyway?"

Joyce Frost, partner at derivatives advisory firm, Riverside Risk Advisors LLC, said the timing of such probes is often politically motivated. "This is happening after the passage of Dodd-Frank and just as competition among derivatives clearinghouses is heating up. Any sooner and it would have been premature," she said.

The European Union's competition commissioner, Joaquin Almunia, said Friday he is reviewing arrangements between CDS data provider Markit Group Ltd. and 16 dealers to determine whether they have "abused [their] dominant position [to] control the financial information on CDS" by giving "most of the pricing, indices and other essential daily data only to Markit."

Separately, the commission is reviewing whether IntercontinentalExchange Inc.'s (ICE) European CDS clearinghouse has special fee arrangements with nine dealers that "might create an incentive [for them] to use only ICE" instead of competing clearers.

Dealer-on-dealer CDS trading accounts for 67% of the $28 trillion of global credit derivatives recorded in the industry's CDS data warehouse, run by the Depository Trust & Clearing Corporation.

Commission spokeswoman Amelia Torres said in an email Tuesday that the commission sees antitrust enforcement as "complementing" pending derivatives regulation.

Others believe that the investigation will only highlight concerns first raised when the U.S. Justice Department confirmed it was running a similar investigation in 2009, and that regulators are already seeking to address those industry turf wars.

In one corner is ICE Clear Europe, the leading CDS clearinghouse, which gets its prices from Markit. In the other is CME Group Inc.'s (CME) European CDS clearinghouse, which gets prices from subsidiary CMA Datavision and Fitch Solutions, a unit of Fitch Ratings. LCH.Clearnet SA, a third provider that so far offers CDS clearing only in Europe, uses Markit exclusively.

ICE has a profit-sharing agreement with dealers who were the original owners of The Clearing Corporation, which ICE acquired in March 2009 as a predecessor to its CDS clearing service. Markit is majority-owned by dealers, after selling a minority stake to private equity firm General Atlantic in January last year, but is also part owned by employees. Fitch is owned by Fimalac SA (FIM.FR) of France.

At issue is the fact CMA Datavision does not receive end-of-day prices from the major CDS dealers, whereas Markit and Fitch do. That may put CME Clearing Europe at a disadvantage, market participants say, because internal risk departments at the dealers screen the end-of-day prices for outliers that might skew the numbers, making it some of the most reliable data available.

Clearinghouses need accurate end-of-day prices to mark members' positions and set margin payments in support of open contracts. In futures trading, the daily settlement prices are determined by exchanges, but in OTC trading, clearinghouses depend on member firms to provide prices. When trading is thin, they rely on secondary sources.

CME uses CMA Datavision and Fitch as secondary sources, a spokesman said. ICE uses Markit as its data provider, but a spokesman declined to comment on its business.

Markit, CMA and Fitch are the only providers of independently sourced, consensus CDS prices used by clearinghouses. Other data providers, such as Bloomberg, redistribute CDS prices to market participants but do not have proprietary CDS data.

Markit gets CDS prices from about 23 dealers to produce its end-of-day prices and "has no exclusive arrangements with any data provider," a spokesman said. Fitch uses prices from 20 dealers. "We don't say who they are, but they are tier-one sellside market makers," said Diana Allmendinger, research director at Fitch Solutions.

CMA gets prices by parsing e-mails from dealers to 36 investment firms, aggregating data where possible to produce continuous prices. It relies on its relationships with buysiders, said a CMA official; any prices it gets from dealers come only from second-tier market makers for comparison purposes.

What allegedly separates Markit is how often it sees CDS prices, and the quality of data it receives. Markit provides prices on 2,882 individual entities globally daily, while Fitch covers about 2,400 single entities. Each also quotes nearly 400 index prices. CMA's data are not as broad in terms of the number of entities quoted, since it is only able to access prices on about 1,400 to 1,600 individual issuers a day, based solely on what is sent between sellside and buyside firms.

Markit also sends out prices more often than the others: real-time data for indexes (and on a 30-minute delay for individual issuers); real-time quotes on request for eligible customers; intraday prices six times a day, after the close in each time zone; and an end-of-day snapshot at 7 a.m. in London. Fitch produces only an end-of-day snapshot. CMA produces hourly updates.

In terms of data history, Markit has 10 years of single-name CDS prices and eight years of history for CDS index prices; CMA has eight years of historical data; and Fitch has CDS data going back to 1999, having acquired CDS pricing company ValuSpread from Lombard Risk Management Plc in 2005.

Asked why Fitch is not being investigated when it, too, receives data directly from dealers, the Commission spokeswoman said, "the Commission does not look into all agreements and at the behavior of all companies; only those that may contain practices that are restrictive of competition and at companies that may have a dominant position and be abusing it."

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